Hybrid Loans: What to Consider

A hybrid loan is a type of mortgage that begins at one fixed mortgage rate and, at a set amount of time in the future, converts to an adjustable rate. For example, a consumer may elect to have 8 years fixed and then an adjustable rate each year thereafter. The introductory fixed rate is generally very low.

Advantages of Hybrid Loans

Hybrid loans are a good option for people who will not maintain the mortgage for the life of the loan. For example, if you know you will be moving in 4 years when you complete your medical residency, a hybrid loan may offer you the lowest rate for those five years. Likewise, if you anticipate a change in your ability to pay that will allow you to pay off the mortgage before it begins adjusting, you will stand to benefit from the low introductory rate. Hybrid loans can be attractive for those who are in their first home. These people generally have a lower down payment and shorter credit history that may initially push them into a higher rate.  Keeping their rates low for the first few years will save them money in the long run. When the rates adjust, these home owners will likely be in a higher pay bracket and can afford the higher monthly payments.

Disadvantages of Hybrid Loans

The biggest disadvantage of hybrid loans is that they undoubtedly will adjust to a higher rate if not paid off. Because the initial teaser rate is typically very low, the rate adjustment can mean a very large difference in the monthly payment. When home owners select these loans under the assumption they will move before the rates adjust, changes in the market condition can alter these plans. Adjustable rate mortgages have been a major player in the rising foreclosure rate across the country. Individuals and families who anticipated raises and promotions to help pay for increasing mortgages did not realize these hopes. They have been left with mortgage payments that they cannot meet each month.

What to Consider

The two most important factors in the adjustable rate you will face are the margin and cap you agree to when you sign your mortgage agreement.  The margin cost relates to the Treasury rate or the Fannie Mae Libor index. Your margin cannot be a certain amount above one the index that you choose to base it on. The margin is expressed on a point basis. The cap of the mortgage states how much the rate can increase to over the life of the loan. For example, if your agreement stipulates a 5% cap, then it will never increase to beyond 5% more than the initial low rate. If you can keep these two numbers fairly low, you will be able to control the adjusting rates and ensure you receive the benefits of a hybrid loan.

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